Companies in the computers/software space—especially the smartphone industry—face an daunting risk of patent lawsuits, which has prompted them to spend a LOT of money on patent portfolio acquisition for the sole purpose of securing their “freedom to operate.” Companies amortize the cost of buying their freedom to operate by baking it into their prices, so we as consumers effectively pay the incremental amount–which flows as a lump sum acquisition price to a small number of patent portfolio owners. If society is getting commensurate incremental benefits from these patent portfolio owners, then the patent system is working just fine; but if we aren’t getting that benefit, and instead this tax is incurred because of the costs of litigating patents, then the system is very deeply broken.

This conference was unusual in that it was focused almost entirely on defense-side considerations (the lunch panel was the main exception). Most academic conferences seek “balance” in the form of intellectual diversity; i.e., for every plaintiff expert, there is a defense expert intended to counterbalance the plaintiff perspective. We take balance very seriously at our conferences, but this time we suspended the rule because of the complexity of the defense-side issues and the import of defensive perspectives to the Silicon Valley community. In fact, very few geographic communities could support a defense-focused patent event, but we had a strong showing of about 200 people attending.

Although I was an enthusiastic supporter of this conference, the real “brains” behind it were Robert Barr of BCLT and especially my colleague Colleen Chien, who is doing important and fresh work in this area. See her SSRN page, and follow her at Twitter.

This post provides my notes from the day. As usual, these are not verbatim transcripts, they are my impressions of the speaker’s remarks. Please confirm any statements before relying on them or attributing them to the speakers. We will be posting a video recording from the conference so you can enjoy the event yourself if you missed it.

Robert Barr (UC Berkeley). To talk about Defense 2.0, we need to define Defense 1.0. Defense 1.0: companies file lots of patents either for cross-licensing or mutually assured destruction. Companies built their portfolios with little supplemental buying of patents. Litigation between operating companies remains a big deal, but NPEs/PAEs have emerged as well.

Laura Sydell (NPR).

She’s not opposed to patents, and she doesn’t want to blow the whole system up. Yet, when she would say “patents” around people in the tech world, people would grimace. Many Silicon Valley people don’t seem to like them.

Intellectual Ventures lab is an amazing company. When it said that best inventors may not be best businessmen, this message resonated with her; it parallels her experiences with artists, who may be gifted artistically but not with business acumen. So she asked IV for an example of success story, and they mentioned Chris Crawford. Her response to investigating him “shocked” her.

Crawford’s patent was messy. NPR had 3 patent attorneys review it (not all of that got mentioned in her story). Their response: this patent wasn’t novel. Then, IV sold the patent to Oasis Research (but retained a cut) and sued lots of cloud companies, and all of the defendants seemed to settle because it was cheaper to license than sue.

Laura and her peer went to visit Oasis Research in Marshall, TX and found an empty office. That didn’t jibe with her thoughts about “innovation.” But it was hard to get anyone to talk due to NDAs. Plus, IV is feared in industry. Inventors feel they don’t pay well.

Laura was struck that the Crawford patent wasn’t a unique story. Instead, there appears to be a whole industry built around similarly weak patents.

Since her story aired, issue has exploded. Companies are spending billions of dollars to defend against lawsuits. The patent reform bill didn’t solve any problems.

Q: how did inventors feel about her piece? A: inventors have been mostly positive. Inventors don’t like IV. Most criticisms about the story came from lawyers instead.

We’re experiencing a tectonic shift. We had a patent market and it was growing, but the mobile industry has accelerated the issues. Mobile wars + increasing patent liquidity has encouraged companies to revisit their portfolios. Are the portfolios robust enough? If the portfolios are strong, should they sell or enforce?

Purchasing patents is a quicker way to fill portfolio gap than filing new patent applications. Buyers can use brokers, but brokers have limited selection, buyers can’t trust broker’s motivations (they also dealing with NPEs), and the brokered patents are crappy (making them more valuable to NPEs because of litigation ambiguity). Buying directly from sellers: buyers can take advantage of information asymmetry and find highly useful patents, but it can take more effort.

HP, IBM, AT&T have active patent sales programs, but their patents are encumbered with existing licenses and other restrictions. Some Korean/Japanese companies won’t sell at all.

Jeff Draeger (Intel)

Bah humbug. When it comes to patents, the mobile industry is special compared to other industry niches. We’re not seeing the same activity in other industry sectors. Mobile: has big new winners and losers. Wireless patent mania will be waning—the wireless connection isn’t the biggest value-add to the mobile devices, and big players have already made their key purchases.

No rational valuation based on royalties to justify purchase prices. NPEs were at the Nortel auction, but the price got too high. In contrast, operating companies feel huge pain with an injunction against their products.

There are a lot of portfolios on the market. NPEs will be buying at inflated prices and then hitting up operating companies to get paid. But with trends in damages, injunctions and joinder, NPEs won’t be able to recoup their money.

Industry détentes may get destabilized if the companies have a different revenue position or liquidate their patents to NPEs. Companies can’t assume any more than sleeping dogs will lie.

Eugene Kim (Zynga)

Smaller companies need to be strategic about which organizations to join. Patent prices are going up across the board. Valuations were striking about Nortel/Motorola Mobility. There isn’t a magic formula for valuating patents. Over time, finance/accounting people are going to demand information about ROIs. Patent litigation avoidance is difficult to quantify.

Xiang Wang (Orrick China)

Chinese companies are filing more patent lawsuits, but damages are much less than US. Companies will inevitably face Chinese patent lawsuits.

Panel 2

Paul Roeder (HP)

HP is defending 80 patent cases, almost all by NPEs/trolls.

1) Fed Cir is demanding “sound economic damages”—junk arguments don’t work. Defendants should be proactive about computing damages. There’s no separate damages “team” among defense lawyers—everyone should be on the team. Discovery needs to consider damages. Defendants should be attacking damages on summary judgment.

2) Apportionment of damages. Defendants should focus on incremental value added from the patent. To get around this, the plaintiffs are turning to the ITC because damages are irrelevant there. But he thinks most cases in ITC shouldn’t have jurisdiction for lack of domestic activity.

3) Prior licenses as market comps must be analogous.

Karen Boyd (Turner Boyd)

Defendants can consider reverse bifurcation. When a small defendant tried to accelerate its damages calculation, the plaintiff instantly dropped the case against that defendant.

Small defendants shouldn’t just rely on the bigger defendants. There’s value to being a leader in the defense group. Incentive for plaintiff to settle with that defendant because the joint defense group might fall apart. But many small defendants can do some coattailing on the smart lawyers who are part of the joint defense group.

Small defendants can challenge personal jurisdiction.

In ND Cal, take a look at Local Rule 3.2. Corporate disclosure rule. It requires disclosure of all parties that have an interest in the litigants. Small defendant can use this rule to its benefit.

European software developers are being approached by patent trolls. Some developers are considering avoiding the US market—it’s only 25% of the market for some of them. Patent trolls are like the Mafia—you get a knock on the door, and they get too involved in the target’s business.

Appsterdam’s goal: open source the prior art research.

There has be a change legislatively, such as exclusions against small business defendants, or limits on damages for patentholders who aren’t practicing. Right now, patents are just a tool to build a business around litigation.

Q: do NPEs ever have a gem patent? McCoy’s answer: Probably not.

Roeder comment: get off the issue of patent quality. Fight the battle on other grounds. We need a system that recognizes that if there are 10k patents on data mirroring, none of them are worth squat.

Q: what effect of AIA joinder requirement? Boyd A: it will provide evidence of just how much NPE litigation is taking place. Luftman A: joint defense collaboration is going to be much harder. Defense lawyers are going to have to step up their game. If competitor gets sued, don’t assume you dodged the bullet; you may need to get involved at that point, even before you get sued.

Lisa Buccino (SAP)

If defendant fights, NPEs sense opportunity to get a win. If defendant loses, NPEs can capitalize on the fear of another loss. Finding ways to reduce litigation costs is an effective response to NPEs—“I don’t mind being sued because it won’t cost me a lot.” Ex: sole-source all patent defense to one firm for fixed fee. Then, each NPE’s suit doesn’t have a marginal cost of defense.

Roeder comments: having large docket makes budgeting easier to manage. They study the data that hourly billing creates—study task codes and compare among firms. It becomes a quality measure for firms. Quality isn’t just having a good argument. Luftman: he appreciates when firms demonstrate their project managing skills, including a dedicated case administrator.

Q: defense contingency arrangements? Buccino A: can set up bonuses for achieving dismissals at certain milestones.

Doug Luftman (CBS)

Settlements with NPEs make matters worse for the tech industry. In other industries, defendants focus more on reducing defense costs than taking easy settlements.

Bring reexaminations before you get sued. This means you need to keep track of what’s coming through the system. Problem: too many patents to track. Solutions: outsource to third party vendors.

Another idea: offer a bounty for busting patents, such as by paying for prior art. (Article One).

Europe has NPEs, such as IPCon. European courts generally are more willing to give permanent injunction than US courts; it’s automatically given when patent owner wins. If this becomes the EU-wide standard, it will give huge leverage to NPEs—they can wipe out the entire European market for their defendants.

In Asia, Asian countries have companies that buy patents that could be asserted against local companies.

Jim Peacock (NociMed): he can’t remember last time when big companies looked like victims. NPEs need better branding to be treated more charitably.

It takes $25M to get to market, and patents are essential to get return on that investment. Emerging companies may decide to partner with an enforcer such as Acacia. This provides a financing source, and it’s a good alternative to a contingency litigation enforcement.

Wild: Micron bitched about NPEs and then sold 20% of their portfolio to NPEs. It’s overly simplistic to say operating companies = good, NPEs = bad. There are too many linkages between the two communities.

Peacock: he’s OK with getting a reasonable royalty instead of an injunction. 25% rule was too high; he never saw royalties like that in the field.

Wild: Europe isn’t an inventor’s paradise. There are plenty of factors why the innovation environment is better in US. China is on a buying binge to purchase patents.

Q: Does the NPE liquidity market encourage inventors to do more research? Tom Ewing: do inventors think they are getting a fair share? Does it encourage the right innovation? Wild: small inventors aren’t driving patent filings; it’s the big companies doing it. Big companies are flooding the PTO with applications, which has actually hurt the patent quality review. Peter Menell: mutually assured destruction got everyone into patent game; but once folks built expensive defense-oriented patent portfolios, they realized that they needed to monetize. Could we jack up the maintenance fees to clean out junk patents?

Ewing: about 30% of world’s active patents are in US = oversupply of patents? European countries may have relative undersupply.

Peacock: biggest concern as entrepreneur is the maintenance fees he faces in Europe.

Market Solutions Panel

Jason Schultz (Berkeley)

He’s developing a scheme for defensive patent licensing. Companies would make a commitment not to sue if licensees make the same commitment back. This would prevent these patents from being sold to trolls. Analogous to open source licensing programs.

Dan Lang (Cisco)

How to get around prisoner’s dilemma? Industry-wide collective responses better than individual responses. So the industry should try to head off bad patents before they hit the market.

Tom Ewing (Avancept)

We use too many military metaphors in patent discourse! Industry groups can file oppositions to all patents that read on the industry.

Kim Cauthorn (Duff & Phelps)

Patent insurance isn’t magic bullet. The patent insurance industry is taking a while to develop due to a lack of data; insurers can’t build full actuarial tables. NPE settlement experience actually helps quantify the risk. Further, patent insurance isn’t a must-have, unlike car insurance. Ironically, D&O insurance is popular even though D&O lawsuits are far rarer than patent litigation.

Q: how does antitrust apply? Schultz: antitrust challenges to open source provide some guidance. The contract is bilateral even if there are benefits for the industry, so no collusion.

Ewing: valuation problem comes from lack of data. If we could get the data, there are plenty of people who can crunch those numbers.

Becky Eisenberg (University of Michigan)

Maybe the costs in the patent system aren’t inherently bad. They force patent owners to make their choices wisely.

Different patent universes:

Notional: everything that could be patented

Nominal: technology that’s actually covered by patents

Effective: patents that are actually asserted/licensed

Due to costs, nominal < notional and effective < nominal.
But costs imposed on non-patent owners. Perhaps nominal > notional because PTO does a bad job and defers to court.

Technology users: incur costs to research/diligence patents and deal with assertions against them.

Plaintiffs can get economies of scale from enforcement. Surprising that NPEs didn’t arise earlier. Pressures to change cost allocations.

Data-Driven Risk Management Panel

Josh Walker (Lex Machina)

Hypothesis: predictive modeling will transform how finance looks at litigation. Based only on knowing the parties, lawyers, venue, etc., Lex Machina could predict the outcome of a case with 64-85% accuracy.

Mike Mazzeo (Northwestern Business School)

Predicting Patent Infringement Awards: 8 largest damages cases were 47-48% of total damages awarded in 340 cases over 13 years. Top 2 most impactful factors (slide went too fast!):

• case decided in Court of Federal Claims

• Awards decided at jury trials

Colleen Chien (Santa Clara University)

Predicting Patent Litigation. Patents in litigation look different than patents that don’t. Factors more prevalent with litigated patents: transfer, setting change, reexam, maintenance, securitization, forward cites. Lesson: there need to be a sorting mechanism between patents that may be litigated or not.

Mallun Yen (RPX)

RPX looks for patents that may be litigated and buys them up before they’ve been asserted. NPE litigation activity is on the rise: 15% from 2005-10. Expected increase 36% in a year. Total defendants—expected to increase 20% in a year.

Mark Lemley (Stanford Law)

AIA started out to curb litigation abuse, but 9 years later, what resulted does very little towards that. Import of Patent Reform for litigators (see his full article):

* Effectively eliminates patent marking suits

* Tax strategy patents: automatically not novel. Bypass: people will argue they merged a tax strategy with a computer, but that can’t be what Congress meant. So perhaps will this take a bite out of business method claims more generally.

* Effectively eliminates best mode requirement. PTO can reject for lack of best mode, but this is highly unlikely to occur.

* Joinder changes. Parties/courts can’t join multiple defendants or consolidate trials unless the parties have common issues of facts, and violation of the same patent isn’t a common issue of fact. This raises the plaintiffs’ costs. But will courts relate cases together? Only if they’re in the same district, but cases are going to scatter on jurisdictional bases. If the cases aren’t related, then plaintiffs are subject to multiple jeopardy (they have to defend their patent in every case or res judicata will kill the patent for good). Interesting strategic choices for defendants: do I want to go first? If I want, I hope the other defendant wins, in which case I get to free ride. But if first trial isn’t with strongest defendant, I might be disadvantaged by going second. Complicates joint defense agreements—lawyers may be arguing the same case in different jurisdictions, and there may be more conflicts between defendants. [Eric’s note: big-scale products liability lawyers have been dealing with these who-goes-first tactical issues for decades. Patent litigators are going to have to learn a thing or two from them.]

* Exclusive federal court jurisdiction even for counterclaims. Reverses Holmes v. Vornado. Some cases in state courts (over, say, license or malpractice) can be brought into federal court.

* Prior user rights. Current provision never has been used. Now it’s expanded. Interesting Qs about exhaustion and the implications for company M&A. Mark thinks it will apply in a small set of cases.

* Can change inventorship at any time; errors in inventorship not a ground for invalidity or inequitable conduct

* Supplemental examination to fix any inequitable conduct during prosecution.

* Advice of counsel/inducement. Failure to obtain advice of counsel can’t be used as evidence of willful infringement or inducement. Effective date for patents filed after September 2012, so this won’t be relevant for many years.